Cochrane on consumer financial protection

The John Cochrane shadow-blogging continues...

Cochrane has two posts up about consumer financial protection. The first is about the negative impacts of anti-usury laws:

Even a well-intentioned usury law has the unintended consequence that poorer, smaller, less well connected people find it harder to get credit.  And it benefits richer, well-connected incumbents, by keeping down the rates they pay, and by stifling upstarts' competition for their businesses... 

Here are just a few of the fun facts.

• Tighter usury laws led to less credit. People didn't easily get around them.

• Tighter usury laws led to slower growth. A one percentage point lower rate ceiling translates in to 4-6% less economic growth over the next decade. 

• Usury laws only affect the growth of small firms. Big firms do fine...

Now let's think about our massive financial regulation and consumer financial "protection." Let's guess who will end up benefiting...

This seems right to me (and Cochrane cites some research to back up these points). Anti-usury laws don't seem to have worked out too well in the past, either in terms of boosting economic performance or creating a more equitable society. Another downside of such laws, which Cochrane doesn't mention, is that anti-usury laws can lead to the proliferation of mafia loansharks.

The rationale for consumer financial protection in the U.S. - the main argument in favor of the Consumer Financial Protection Bureau - has always been that many modern financial products are too complex for consumers to understand (leading to either people being tricked, or markets breaking down because people fear being tricked). But high interest rates are not complex. They are very simple. People do not need government help to understand high interest rates. This means that the CPFB should ideally focus on complexity (and on behavioral effects that allow companies to repeatedly deceive consumers), not on the tightness of lending standards in general.

Cochrane's second post argues that since regulators are subject to behavioral biases, the CFPB will be no better at evaluating financial products than are the consumers that the agency is meant to protect:

Behavioral economics does not imply aristocratic paternalism. Behavioral economics, if you take it seriously, leads to a much more libertarian outlook. 

Which kinds of institutions are likely to lead to behavioral biases: highly competitve, free institutions that must adapt or fail? Or a government bureacracy, pestered by rent-seeking lobbyists, free to indulge in the Grand Theory of the Day, able to move the lives of millions on a whim and by definition immune from competition?  

Sure, the market will get it wrong. But behavioral economics, if you take it seriously,  predicts that the regulator (the regulatory committee) will get it far worse. For regulators, even those that went to the right schools, are just as human and "behavioral" as the rest of us, and they are placed in institutions that lack many protections against bad decisions. 

More generally, the case for free markets never was that markets always get it right. The case has always been based on the centuries of experience that governments get it far more wrong. 

This does not seem right to me. I don't think that behavioral theories apply to regulators in the same way that they apply to the people that the regulators are supposed to protect. 

For example, many behavioral theories rest on the idea that consumers are overconfident and exhibit considerable self-attribution bias. Regulators, when evaluating a financial product being sold by Company A to Consumer B, will presumably suffer from these same biases, but not in the same way. An overconfident consumer may say "Housing prices will always go up," even if a dispassionate analysis says that they won't. A regulator, by contrast, may be overconfident in general, but she won't be overconfident about the price of the consumer's house! 

So, just saying "regulators are people too" doesn't prove anything. The point of behavioral economics is not just to say that "people make mistakes"; it's to point out what kind of mistakes people make, and when.

(I should note that variants of this argument - "Governments make mistakes too!" - are extremely common among opponents of regulation. But just to say "Governments make mistakes, therefore we shouldn't rely on government for things" seems very wrong to me. We need to study what kind of mistakes governments make, and when. Otherwise we risk making the perfect the enemy of the good.)

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Water Cooler

This guest post from Doris Dillon

It’s funny how much has changed over the last 10 years. 10 years ago, I was still in college going to class a little and partying a lot. Now, I spend my “party” time talking to coworkers in the break room, our version of the old fashioned water cooler. Not only has my life changed, but the topics that my coworkers and I talk about have to. It used to be centered around, movies, tv shows, the occasional book, cars and even the rare political discussion. 

Unfortunately, since the economy has gone the way of the dinosaurs, our talks have now turned to job security, financial planning and cost cutting methods. The other day, while having one of our now regular cost cutting talks, a coworker said that he stumbled on http://www.wildbluedeals.com/ and found a great deal on internet. So of course I had to check it out for myself. And wouldn’t you know it, I was paying way too much for internet. I guess our new topics are a little more helpful than the latest reality show, huh?

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Lower wages can be a good thing

Menzie Chinn points out that recovery in manufacturing and exports has been stronger than recovery as a whole. As an explanation, he cites America's falling unit labor costs. Unit labor cost is just the amount of wages you need to pay workers to produce one unit of output. Because America's unit labor costs are falling, it is becoming more economical for businesses to produce more tradable goods here, and so they are doing so.

This is a useful reminder of a economic principle often overlooked by progressives: There is sometimes a tradeoff between wages and employment levels (which is another way of saying that labor supply curves slope up and labor demand curves slope down). If economic "frictions" or the actions of policymakers hold wages up when economic forces are trying to push wages down, unemployment will often result. 

In the case of trade, what this means is that keeping American wages high can cause unemployment to rise. Starting around 2000, a huge massive glut of Chinese labor was dumped on the world market when China joined the global trade system; this created a tremendous natural downward pressure on American wages. Wages in America have stagnated since 2000, but it's difficult for wages to actually fall. This wage rigidity probably shrunk the size of America's tradable sector. 

But eventually, increases in American productivity have caught up and overtaken stagnant American wages. Here is Chinn's graph:

If you believe Chinn's story, the slow growth of U.S. wages is behind the mini-resurgence in American manufacturing and exports. This is the reality of "competitiveness."

Is this a good thing or a bad thing? Well, if what you care about is higher wages for the people who have jobs, then no. But if what you care about is increasing the total number of people with jobs, then yes. If you believe that our social safety net is good enough to provide for the unemployed by taxing the employed (ha), and that the efficiency losses from artificially high wages are small, then maybe you don't care.

Another example of a tradeoff between wages and employment is in sticky-wage models of the business cycle. In these models - which include many New Keynesian models - wage frictions can increase unemployment by preventing nominal wages from falling in response to a negative demand shock. (Of course, in these models, the optimal solution is for government to use policy to cancel out the demand shock, thus preventing wages from falling while preserving employment levels.)

Lots of people don't like the idea that there is a tradeoff between wages and employment levels. They point to the long run, in which (hopefully) wages rise without causing long-term unemployment. But the short-term is different than the long term. In the case of sticky-wage models, the "short term" may only be a few years. But in the case of trade, China, and "factor price equalization," the "short term" may last until China's wages catch up to ours. That could take decades. 

I believe that the mindset of some progressives - maximize wages at all costs - needs a rethink. When I look at the evidence, I see that higher wages do only a little to increase the happiness of workers, but unemployment is devastating for the unlucky few (and terrifying even for those who manage to keep their jobs). In Germany, labor unions often negotiate wage cuts in order to preserve long-term employment levels. I think we should look at doing something similar. After all, Germany is no blue-collar dystopia.

It seems weird, but lower wages can be a good thing.

Update: Note that if exchange rates were flexible, "competitiveness" would take care of itself through. The fact that unit labor costs matter for trade balances means that exchange rates must be sticky. For those of you who read Japanese, Himaginary analyzes this in the context of the Japanese economy.

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The Trouble with Amazon

Amazon: the new Montgomery Ward

Amazon (let's be honest) is a company in trouble. Oh, its financials are fine. It's profitable, even. It's growing. By all normal metrics, it's not in trouble at all. But common sense says the spit's about to hit the fan. Amazon is on a collision course with destiny—the destiny of all companies who ever tried to do too much (Kmart, Federated Dept. Stores, Montgomery Ward, Allied Stores, Southland Corp., Ames Department Stores, The Circle K Corp.. Carter Hawley Hale Stores—the list goes on). Let's be blunt: Amazon is just another department store, except they have no physical storefront. But lack of a physical storefront doesn't mean they won't suffer the fate of all the unwieldy, poorly managed department store chains that have gone before. History has a way of dealing with do-too-much retailers (and now, e-tailers).

Amazon's business model is a model of confusion. Their business is really three businesses: eRetailing (what Amazon calls EGM: Electronics and General Merchandise), publishing, and cloud services.

According to Amazon's 10K filing, EGM currently accounts for 60% of the business. And that's precisely where the big trouble lies.

Recent indications are that Amazon has reached a tipping point. For 2011, Amazon's net income was a paltry $631 million on net sales of $48 billion. Compare this to 2010's net income of $1.152 billion on $34.2 billion in net sales. Basic earnings-per-share has gone from $2.58 (2010) to $1.39 (2011).

Basically, Amazon has become a logistics company without wheels. To survive in its present form, it badly needs to acquire an Airborne Express (except that AE has already been acquired by DHL), or maybe a railroad and a package delivery company. Ideally, it also needs to acquire a payment-processing system (a PayPal). Why not just admit the obvious? Amazon needs to acquire eBay.

The alternative is to join the long list of department stores that tried to be all things to all customers (and ended up broke).

Amazon claims it will enjoy greater efficiencies (going forward) by opening more fulfillment centers and putting pressure on suppliers. But their story, frankly, is starting to sound old and is (how shall we say?) at this point painfully unconvincing. Inefficiencies are rising faster than efficiencies, at Amazon. That's what the numbers show. And that's the real point.

You don't have to be a numbers guru to see where Amazon is headed, though. Just look at what Amazon is trying to sell, and draw your own conclusions. The following list was taken directly from the pulldown menu on their U.S. website:

Amazon Instant Video Appliances Apps for Android Arts, Crafts & Sewing Automotive Baby BeautyBooks Cell Phones & Accessories Clothing & AccessoriesComputers Electronics Gift Cards Grocery & Gourmet Food Health & Personal Care Home & KitchenIndustrial & Scientific JewelryKindle Store Magazine Subscriptions Movies & TV MP3 Downloads Music Musical Instruments Office Products Patio, Lawn & Garden Pet SuppliesShoesSoftware Sports & OutdoorsTools & Home Improvement Toys & Games Video Games Watches 

I've highlighted certain items that are emblematic of Amazon's ongoing megalomaniacal bid to be everything-to-everyone. Amazon is trying to out-Sears Sears. But we all know what's happening to Sears. And it ain't pretty.

Amazon's legacy: empty strip malls everywhere.

Amazon hasn't been completely ineffective. For every one of Amazon's 69 fulfillment centers, there are probably five to ten Staples stores out of business, ten or twenty Barnes & Nobles stores gone, a dozen hardware stores gone, several pet supply stores, and maybe a Toys R Us or two. To see the devastation wreaked by Amazon, you have only to cruise the half-empty strip malls in your local neighborhood. Amazon is sucking $50 billion a year out of local economies, worldwide.

Where Amazon excels, of course, is in book reselling, e-book publishing, and Kindle sales (although they are rumored to be taking a $15 hit on every Kindle Fire sold). This is where Amazon's monopoly power lies. This is where they have the power to dominate, not merely decimate.

Amazon also does well as a cloud-services provider. They can legitimately claim some high ground here.

But in patio, lawn, and garden equipment, sports equipment, kitchen and bath fixtures, and numerous other areas, they're never going to have monopoly power.

In short, the parts of Amazon that deal in electrons are doing well. The parts that deal in protons are not doing so well. That's the crux of the matter.

One day, Jeff Bezos is going to have a Bain Capital moment and recognize that he's in way over his big fat head. There'll be a sudden "huge restructuring" of the business. Big writeoffs will be taken. Apologies will be issued. The stock price will plummet. And Amazon will emerge a much smaller (but more profitable) company.

Either that, or (if Bezos continues to think like a megalomaniac) Amazon will simply hit the wall, hard. And the smoking shards will blanket the earth.

I wonder if they sell hard-hats?

Disclosure: The author has no stake (long or short) in Amazon stock.

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Tyler Cowen pounces on Keynesianism

The new payroll numbers are out, and the numbers are good. Tyler Cowen interprets the numbers to be a big refutation of Old Keynesian macroeconomic theories:

The “big loser” here?: Old Keynesianism.  You really can get a recovery when the real shocks are moderately positive.  You will note, as we have been told many many times by many many sources, fiscal and monetary policy have not been extremely pro-active in recent times; in fact the stimulus has been trickling to a close.  The big winners, apart from the American public?: real business cycle theory.  It is part of any cyclical explanation, whether one likes it or not. 

Another big loser is those liquidity trap theories which tell us that positive real shocks are bad for the economy because the AD curve has a perverse slope, etc., and that negative shocks might help spur recovery.  That theory is looking very weak, again.  I consider it the weakest economic theory that has any currency in the serious economics blogosphere.

In response, Ryan Avent tweeted: "What on earth is Tyler Cowen talking about?" I have to say, I share Ryan's sentiment. Here are the issues I have with Cowen's interpretation of the data:

1. This is one month of data. I think it may be time to add another principle to my list of Principles for Arguing With Economists: "One-Tick Economics" does not work. Time series are stochastic; one month of data, no matter how good or bad, is not enough to refute or support any macoreconomic theory. For reference, courtesy of Brad DeLong, here is a graph of the labor force/population ratio, with the most recent good news highlighted at the end:

Look carefully at that graph. Do you think that tick is enough to disprove Old Keynesianism and the liquidity trap, and provide strong support for Real Business Cycle theory? Tyler says yes. I say: Highly unlikely. To evaluate their models, macroeconomists look at time series containing hundreds upon hundreds of such data points, and it's still incredibly difficult to evaluate competing macroeconomic theories. One more month is not going to come along and settle the argument. Sorry. It just isn't.

And did Cowen seize on every month of terrible employment growth over the past three years to say "Wow, Real Business Cycle is the big loser from this data, and the big winner is Old Keynesianism!"? No, he did not.

2. Growth rates and levels are different things. Even if last month's good numbers signal that the economy is recovering, it is still in a deep hole. It has not recovered yet. To support this contention, let me cite a post from Tyler Cowen from two days ago:

[W]hat is striking about the broken line above isn’t where it now ends — at 10.3 per cent — but rather the lack of any meaningful, sustained improvement for more than two years. 

This alternative measure [of unemployment] has remained above 10 per cent since September 2009, and aside from a bit of skittishness (some of which is down to uncaptured seasonality) has mostly just moved sideways. 

So, over two years of complete employment stagnation do nothing to strengthen the case for liquidity traps in Cowen's mind, but one month of good employment numbers relegate Old Keynesianism to the dustbin of history. Right. Got it.

3. The "liquidity trap" is not as bad as it was before. Tyler apparently believes that liquidity trap theories dictate that an economy in a liquidity trap must experience poor employment growth each and every month of the year, unless and until the government launches a sufficiently large intervention. That is a massive, ridiculous straw-man. Liquidity traps are not held to last forever. In fact, here is evidence from Greg Mankiw that the U.S. may be out (or almost out) of a liquidity trap.

4. Where's the "real shock"? Tyler Cowen says that the latest data show that "You really can get a recovery when the real shocks are moderately positive." Does he have any data to show that we have experienced a "moderately positive real shock"? What kind of shock is he talking about? A positive technology shock? An uptick in people's willingness to work? I want to see this shock identified! (And make sure it's a structural shock..."higher manufacturing orders" does not count.)

More broadly, Cowen says: "The big winners, apart from the American public?: real business cycle theory." So, presumably, the three straight years of poor economic performance were caused by negative real shocks? By poor technological progress and/or people deciding they'd rather not work? Is Cowen really willing to make that argument?

To conclude: I am not saying that Old Keynesianism is right. I am not saying that liquidity-trap theory is right. What I am saying is that one month of data does not prove these theories wrong at all, especially when employment is still far below previous levels, and especially when there is evidence that the "liquidity trap" is not as severe as it once was. And what I am saying is that this one month of data does not in any way represent a vindication for Real business Cycle Theory, especially if I can't see the "real shock."  

Look, if you sit through three years of economic stagnation, watching and waiting for any single month of good employment data, and then as soon as one comes along you jump out and pounce and yell "See? Keynesianism is wrong, Real Business Cycle Theory wins!!!", well, eventually you're going to get your chance. But your conclusion, from a scientific standpoint, will be incredibly premature.

Show me half a year of solid growth under a regime of relative austerity and hard money, and I promise you I will seriously re-evaluate any and all of my own ideas about the relative importance of "real" and "nominal" shocks. We aren't there yet.


Update: Brad DeLong, quoting Keynes, reminds us that Old Keynesians believe that economies eventually recover without stimulus; they just think that stimulus makes them recover faster. Does Cowen really think that Old Keynesians believe that an economy will never emerge from recession without government action???


Update 2: Tyler Cowen has a lengthy response. His points:

* He says he against Old Keynesianism but not New Keynesianism (fair enough).

* He says that Old Keynesiansm predicts less mean-reversion in growth than does New Keynesianism (not sure that is right, see DeLong post above).

* The "recovery" is coming right after the end of fiscal stimulus (not a strong argument; including state govt. spending there was no stimulus)

* The Old Keynesian "paradox of thrift" seems to be more applicable in the middle of a crisis than during a slow recovery (um...that sounds to me like a vote of confidence for Old Keynesianism...)

* The Mortensen-Pissarides labor search model matches RBC theory, not Keynesianism (um...that's because RBC is part of the Mortensen-Pissarides model. Which, as it happens, also doesn't match a lot of important fact about recessions, as Robert Shimer has pointed out.)

* Corporate profits are strong (This actually is much worse news for New Keyensianism than Old!)

* "Real business cycle" models actually include most economic models and phenomena (Except, of course, all models that are used by central banks and professional macro forecasters!)

So, there you go.

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Thursday Roundup (2/2/2012)

Posts you may have missed in the blogosphere this week...Ride em econ cowboys!

1. Matt Yglesias reminds us that it is never wise to give our money to the experts, no matter how much money they make for themselves.

2. Tyler Cowen argues that inequality, at least recently, has been mostly about stagnating incomes and the explosion of the income of the top 0.1%. Very true. (Tyler's post also contains some insults in an addendum at the bottom, which I do not endorse.)

3. John Cochrane demonstrates the perils of over-differencing time series data. This is a specific case of a very deep problem with time series econometrics: rigid lag structures.

4. Steve Keen has a great essay on the problems facing the field of macroeconomics.

5. James Kwak explains how private equity works, how it is is supposed to benefit the economy, and how it might not actually benefit the economy.

6. David Glasner reminds us that Reagan didn't think 4% inflation was such a bad thing.

7. Brad DeLong uses an equation to explain his thinking on fiscal policy. Unlike a lot of people in the blogosphere, I love it when people do this. And here, he explains his thinking on monetary policy. Read!

8. Scott Sumner points out that Britain talks a lot about austerity but has actually been running big budget deficits.

9. Intra-blog civil war at Modeled Behavior, as Karl Smith doubts that government workers can be overpaid, while Adam Ozimek thinks they most definitely can. I score this one for Adam (to see why, consider the marginal product of Chairman Mao and compare it to his total compensation package). In fact, Adam is so obviously right that I hereby award Karl a bat boy! ;-)

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Who cares how "deserving" the poor are?

Bryan Caplan is apparently about to debate Karl Smith on the question of "How deserving are the poor?" I want to get my two cents in ahead of this debate, by asking the counter-question: "Who cares?"

The question of "How deserving are the poor" is a matter of opinion. There is no right answer, because to say someone "deserves" something is a prescriptive statement, and you can't prove those with facts. Also, it is a somewhat pointless question, because no matter what answer you decide you like, it doesn't really imply any particular policy prescription. In practice, people who say "The poor deserve to be poor" are usually just trying to push the idea that we shouldn't try to do anything about poverty other than scolding the poor for their own mistakes (I'll come back to this idea in a bit). But this doesn't really follow.

As I see it, there are two important questions about poverty from a policy perspective: 

1. Do we want to make poor people less poor?

2. If we do want to do that, how do we accomplish it?

Bryan Caplan's answer (and Tyler Cowen's) to the question of "How deserving are the poor" is that if people are poor mainly as a result of their own actions, then they deserve to be poor. But as I see it, whether people are poor because of their own actions doesn't really help us answer either of the two questions I posed above.

Regarding the first of my questions, "Do we want to make poor people less poor", it may be that your sense of morality tells you that if someone is in a condition as a direct result of their own actions, it would be wrong to try to remove that person from that condition. Fine, good for you and your sense of morality! But for my part, I simply don't care. If I am getting mugged by a poor person, I quite frankly do not give a rodent's gluteal region whether that person is poor because he made bad life choices or because the circumstances of his birth made his poverty inevitable; I want him to stop mugging me, and if making him less poor will make him stop mugging me, then maybe this would be a good thing to do, regardless of whether he "deserves" it. When I witness the urban blight, violence, drug abuse, and other social ills that poverty may be causing, as a non-poor person I have an interest in preventing these social ills from affecting me, regardless of whether the ills are "deserved."

Also, whether people are poor because of their own actions doesn't really tell us how to get them out of poverty. Scolding and finger-wagging does not work. Just because a person's actions got him into a situation doesn't mean that his actions can get him out of it. And even if poor people could raise themselves up out of poverty at any time, scolding and finger-wagging is not likely to induce them to suddenly do so. The conservative solution to poverty - make it really, really unpleasant to be poor, and then hope people will do the smart thing and avoid it - has failed and failed and failed again.

So from my point of view, asking whether or not poor people "deserve" their poverty is asking the wrong question.

That said, I think the Caplan definition of "deserve" is not as "uncontroversial" a moral premise as Caplan declares. The reason is that it is a partial-equilibrium definition, not a general-equilibrium one. If we live in a society in which X percent of the populace must be poor, then no matter what set of actions is taken by the population, some people will wind up in poverty. To see this, imagine that we lived in a society in which the hardest-working 50% of people get to be spectacularly rich, and the other 50% are forced to live in squalid poverty. In this society, if everyone raises their effort by 1000%, the number of people in poverty stays exactly the same. I doubt that most people would say that the lower half of the population "deserved" to stay in poverty after raising their effort by 1000%! But that is exactly what Caplan's definition implies. Also, note that in such a world, whether you "deserve" to be poor depends critically on the actions of other people (since the degree of effort required for a person to raise himself out of poverty depends on how much effort others are expending)...thus, Caplan's definition doesn't really seem to capture the notion of individual responsibility.

But anyway, that is a bit beside the point, because in my opinion the whole question is a bit of a pointless one.

Update: Tyler Cowen emails to say that his view of "deserving" is a more synthetic one than Bryan Caplan's. Also, in his post he says "There is the view that desert simply is not very relevant for a lot of our choices.  We still may wish to aid the undeserving." This is pretty close to my thoughts.

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